10-Q 1 d10q.txt QUARTERLY REPORT PERIOD ENDED JUNE 30, 2001 United States Securities and Exchange Commission Washington, D.C. 20549 ---------- Form 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 Commission file number 000-28401 MAXYGEN, INC. (Exact name of registrant as specified in its charter) Delaware 77-0449487 (State of incorporation) (I.R.S. Employer Identification No.) 515 Galveston Drive Redwood City, California 94063 (Address of principal executive offices, including zip code) (650) 298-5300 (Registrant's telephone number, including area code) ---------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ ----- As of August 1, 2001, there were 33,898,085 shares of the registrant's common stock outstanding. MAXYGEN, INC. FORM 10-Q QUARTER ENDED JUNE 30, 2001 INDEX Part I FINANCIAL INFORMATION Item 1: Financial Statements: Condensed Consolidated Balance Sheets as of December 31, 2000 and June 30, 2001 ............................................................................... 3 Condensed Consolidated Statements of Operations for the three and six month periods ended June 30, 2000 and 2001 .................................................. 4 Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 2000 and 2001 ............................................................ 5 Notes to Condensed Consolidated Financial Statements ............................................ 6 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations ........... 9 Item 3: Quantitative and Qualitative Disclosures About Market Risk ...................................... 22 Part II OTHER INFORMATION Item 1: Legal Proceedings ............................................................................... 24 Item 2: Changes in Securities and Use of Proceeds ....................................................... 24 Item 3: Defaults Upon Senior Securities ................................................................. 24 Item 4: Submission of Matters to a Vote of Security Holders ............................................. 25 Item 5: Other Information ............................................................................... 25 Item 6: Exhibits and Reports on Form 8-K ................................................................ 25 SIGNATURES ............................................................................................... 26
2 ================================================================================ Part I - Financial Information Item 1 Financial Statements MAXYGEN, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
December 31, June 30, 2000 2001 ---- ---- ASSETS (Note 1) (unaudited) Current assets: Cash and cash equivalents .............................................. $ 111,374 $ 70,390 Short-term investments ................................................. 110,805 107,023 Grant and other receivables ............................................ 8,425 7,324 Prepaid expenses and other current assets .............................. 1,180 1,649 --------- --------- Total current assets ................................................. 231,784 186,386 Property and equipment, net ............................................ 9,916 11,670 Goodwill and other intangible assets, net of accumulated amortization of $3,418 at December 31, 2000 and $7,781 at June 30, 2001 .............. 22,760 18,397 Long-term investments .................................................. 35,836 74,187 Deposits and other assets .............................................. 1,403 1,611 --------- --------- Total assets ......................................................... $ 301,699 $ 292,251 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ....................................................... $ 2,143 $ 2,124 Accrued compensation ................................................... 1,859 5,812 Other accrued liabilities .............................................. 4,633 3,632 Deferred revenue ....................................................... 6,228 8,640 Current portion of equipment financing obligations ..................... 533 586 --------- --------- Total current liabilities ............................................ 15,396 20,794 Deferred revenue .......................................................... 2,810 2,713 Non-current portion of equipment financing obligations .................... 1,295 993 Commitments Stockholders' equity: Preferred stock, $0.0001 par value, 5,000,000 shares authorized, no shares issued and outstanding at December 31, 2000 and June 30, 2001 . -- -- Common stock, $0.0001 par value: 100,000,000 shares authorized, 33,576,736, and 33,886,335 shares issued and outstanding at December 31, 2000 and June 30, 2001, respectively .................... 3 3 Additional paid-in capital ............................................. 386,026 387,743 Notes receivable from stockholders ..................................... (776) (776) Deferred stock compensation ............................................ (19,880) (12,981) Accumulated other comprehensive income ................................. 587 134 Accumulated deficit .................................................... (83,762) (106,372) --------- --------- Total stockholders' equity ........................................... 282,198 267,751 --------- --------- Total liabilities and stockholders' equity ........................... $ 301,699 $ 292,251 ========= =========
See accompanying notes. 3 MAXYGEN, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
Three Months ended Six Months ended June 30, June 30, ---------------------- ---------------------- 2000 2001 2000 2001 -------- -------- -------- -------- Collaborative research and development revenue ......... $ 3,195 $ 5,972 $ 6,241 $ 10,997 Grant revenue .......................................... 2,960 1,704 5,328 3,609 -------- -------- -------- -------- Total revenues ......................................... 6,155 7,676 11,569 14,606 Operating expenses: Research and development ........................... 7,828 13,031 14,045 25,727 General and administrative ......................... 2,843 3,952 4,856 7,500 Stock compensation expense (1) ..................... 3,191 3,512 8,131 7,055 Acquired in-process research and development ....... 912 -- 912 -- Amortization of goodwill and other intangible assets ......................................... -- 2,182 -- 4,363 -------- -------- -------- -------- Total operating expenses ............................... 14,774 22,677 27,944 44,645 -------- -------- -------- -------- Loss from operations ................................... (8,619) (15,001) (16,375) (30,039) Interest income, net ................................... 4,275 3,455 6,391 7,429 -------- -------- -------- -------- Net loss ............................................... $ (4,344) $(11,546) $ (9,984) $(22,610) ======== ======== ======== ======== Basic and diluted net loss per share ................... $ (0.14) $ (0.35) $ (0.34) $ (0.70) Shares used in computing basic and diluted net loss per share .............................................. 30,188 32,534 29,125 32,359 ---------- (1) Stock compensation expense related to the following: Research and development ........................... $ 1,891 $ 2,875 $ 5,456 $ 5,751 General and administrative ......................... 1,300 637 2,675 1,304 -------- -------- -------- -------- $ 3,191 $ 3,512 $ 8,131 $ 7,055 ======== ======== ======== ========
See accompanying notes. 4 MAXYGEN, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
Six Months ended June 30, ------------------------ 2000 2001 --------- --------- Operating activities Net loss .................................................................. $ (9,984) $ (22,610) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ......................................... 649 1,333 Amortization of intangible assets ..................................... -- 4,363 Deferred stock compensation amortization - employees .................. 6,093 6,899 Common stock issued and stock options granted to consultants for services rendered ................................. 2,038 360 Acquired in-process research and development .......................... 912 -- Changes in operating assets and liabilities: Grant and other receivables ....................................... (3,049) 1,101 Prepaid expenses and other current assets ......................... (351) (469) Deposits and other assets ......................................... (754) (208) Accounts payable .................................................. 524 (19) Accrued liabilities ............................................... 2,266 2,952 Deferred revenue .................................................. (649) 2,315 --------- --------- Net cash used in operating activities ..................................... (2,305) (3,983) --------- --------- Investing activities Purchases of available-for-sale securities ................................ (56,960) (121,332) Maturities of available-for-sale securities ............................... -- 87,543 Acquisition of property and equipment ..................................... (1,093) (3,348) --------- --------- Net cash used in investing activities ..................................... (58,053) (37,137) --------- --------- Financing activities Borrowings under equipment financing obligation ........................... 166 -- Repayments under equipment financing obligation ........................... (29) (249) Equity adjustment from foreign currency translation ....................... -- (972) Proceeds from issuance of common stock - net of issuance costs ............ 137,310 1,357 Payments received on promissory notes ..................................... 491 -- --------- --------- Net cash provided by financing activities ................................. 137,938 136 --------- --------- Net increase in cash and cash equivalents ................................. 77,580 (40,984) Cash and cash equivalents at beginning of period .......................... 136,343 111,374 --------- --------- Cash and cash equivalents at end of period ................................ $ 213,923 $ 70,390 ========= ========= Schedule of non-cash financing activities Shares issued to acquire technology ...................................... $ 827 --
See accompanying notes. 5 MAXYGEN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation and Significant Accounting Policies Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. The information as of June 30, 2001 and for the three months and six months ended June 30, 2000 and June 30, 2001 includes all adjustments (consisting only of normal recurring adjustments) that the management of the Company believes necessary for fair presentation of the results for the periods presented. Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Report on Form 10-K for the year ended December 31, 2000. Principles of Consolidation The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Revenue Recognition Non-refundable up-front payments received in connection with research and development collaboration agreements, including technology advancement funding that is intended for the development of the Company's core technology, are deferred and recognized on a straight-line basis over the relevant periods specified in the agreement, generally the research term. Revenue related to collaborative research with the Company's corporate collaborators is recognized as research services are performed over the related funding periods for each contract. Under these agreements, the Company is required to perform research and development activities as specified in each respective agreement. The payments received under each respective agreement are not refundable and are generally based on a contractual cost per full-time equivalent employee working on the project. Research and development expenses under the collaborative research agreements approximate or exceed the revenue recognized under such agreements over the term of the respective agreements. Deferred revenue may result when the Company does not incur the required level of effort during a specific period in comparison to funds received under the respective contracts. Milestone payments, if any, will be recognized pursuant to collaborative agreements upon the achievement of specified research milestones or the sale of applicable products. Royalties, if any, will be recognized when earned. The Company has also been awarded Defense Advanced Research Projects Agency ("DARPA") grants and National Institute of Standards and Technology-Advanced Technology Program ("NIST-ATP") grants for various research and development projects. The terms of these grant agreements are three years with various termination dates, the last of which is September 2002 for the existing agreements. Revenue related to grant agreements is recognized as related research and development expenses are incurred. Net loss per share Basic and diluted net loss per common share are presented in conformity with the Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), for all periods presented. In accordance with SFAS 128, basic and diluted net loss per share has been computed using the weighted average number of shares of common stock outstanding during the period, less shares subject to repurchase. 6 The following table presents the calculation of basic, diluted and pro forma basic and diluted net loss per share (in thousands, except per share data):
Three Months ended Six Months ended June 30, June 30, ---------------------- ---------------------- 2000 2001 2000 2001 -------- -------- -------- -------- Net Loss ..................................................... $ (4,344) $(11,546) $ (9,984) $(22,610) ======== ======== ======== ======== Basic and diluted: Weighted-average shares of common stock outstanding ....... 32,314 33,832 31,645 33,744 Less: weighted-average shares subject to repurchase ....... (2,126) (1,298) (2,520) (1,385) -------- -------- -------- -------- Weighted-average shares used in computing basic and diluted net loss per share .............................. 30,188 32,534 29,125 32,359 ======== ======== ======== ======== Basic and diluted net loss per share ......................... $ (0.14) $ (0.35) $ (0.34) $ (0.70) ======== ======== ======== ========
The Company has excluded all outstanding stock options and shares subject to repurchase from the calculation of diluted loss per common share because all such securities are antidilutive for all applicable periods presented. The total number of shares excluded from the calculations of diluted net loss per share, prior to application of the treasury stock method for options, was 5,119,000 at June 30, 2000 and 8,132,000 at June 30, 2001. Such securities, had they been dilutive, would have been included in the computations of diluted net loss per share along with restricted common stock subject to the Company's right of repurchase. Comprehensive Income (Loss) Comprehensive income (loss) is primarily comprised of net unrealized gains or losses on available-for-sale securities and foreign currency translation adjustments. Comprehensive income (loss) for the three and six months ended June 30, 2001 includes $226,000 and $781,000, respectively, representing the net change in unrealized gains (losses) on investments. Comprehensive income (loss) for the three and six months ended June 30, 2001 also includes $(1.158) million and $(1.233) million, respectively, representing the net change in foreign currency translation adjustments. Comprehensive loss for the three and six months ended June 30, 2000 was $(44,000) and $(130,000), respectively, representing the net change in unrealized losses on investments. Accumulated other comprehensive income as at June 30, 2001 includes $1.302 million and $(1.168) million for unrealized gains on investments and foreign currency translation adjustments, respectively. Accumulated other comprehensive income as at December 31, 2000 includes $521,000 and $66,000 for unrealized gains on investments and foreign currency translation adjustments, respectively. Derivatives and Financial Instruments Effective October 1, 2000, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. SFAS 133 was later amended by SFAS No. 137 and SFAS No. 138. This standard requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The adoption of this standard has not had a material effect on the Company's consolidated financial position, results of operations or cash flows. At June 30, 2001, the Company had foreign currency contracts in the form of forward exchange contracts totaling $9.0 million. 2. Investments Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. The Company's debt securities are classified as available-for-sale and are carried at estimated fair value in cash equivalents and short-term investments. Unrealized gains and losses are reported as accumulated other comprehensive income (loss) in stockholders' equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses on available-for-sale securities are included in interest income and expense. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income. The Company's cash equivalents and investments as of June 30, 2001 are as follows (in thousands): 7
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value --------- ---------- ---------- ---------- Money market funds ............................ $ 70,390 $ -- $ -- $ 70,390 Commercial paper .............................. 106,230 793 -- 107,023 Corporate bonds ............................... 73,678 509 -- 74,187 --------- ---------- ---------- ---------- Total ...................................... 250,298 1,302 -- 251,600 Less amounts classified as cash equivalents ... (70,390) -- -- (70,390) --------- ---------- ---------- ---------- Total investments ............................. $ 179,908 $ 1,302 $ -- $ 181,210 ========= ========== ========== ==========
Realized gains or losses on the sale of available-for-sale securities for the three and six month periods ended June 30, 2000 and June 30, 2001 were insignificant. At June 30, 2001, the contractual maturities of investments were as follows (in thousands): Amortized Estimated Cost Fair Value --------- ---------- Due within one year .................... $ 106,230 $ 107,023 Due after one year ..................... 73,678 74,187 --------- --------- $ 179,908 $ 181,210 ========= ========= 3. Collaborative Agreements ALK-Abello A/S In February 2001, the Company established a three-year collaboration with ALK-Abello A/S, a wholly owned subsidiary of Chr. Hansen Holding A/S, Denmark, to research and develop novel recombinant therapeutics for the treatment of specific allergies. The Company will collaborate with ALK-Abello to create therapies for treating specific allergies, including allergies to house dust mites and grass, which are the cause of many common allergies. Under the terms of the collaboration, the Company will receive license fees, technology access fees, research and development funding, and potential milestone payments. Such payments to the Company, including milestone payments, could total a maximum of $80 million. The Company will also be entitled to receive royalties on product sales, if any. ALK-Abello will receive exclusive worldwide rights to commercialize all recombinant human therapeutics developed in the collaboration. International AIDS Vaccine Initiative In February 2001, the Company established a three-year collaboration with the International AIDS Vaccine Initiative and DBLV, LLC, an entity established and funded by the Rockefeller Foundation to develop novel HIV vaccines. Under the agreement, DBLV will provide full research and development funding to the Company for at least three years to expand the Company's ongoing program in HIV vaccine development. The Company will retain all rights to commercialize the HIV vaccine candidates in all developed countries of the world, as well as in certain markets in the developing world. 4. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142. Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over the useful lives. The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the nonamortization provisions of the Statement is expected to result in a decrease in net loss of $8.7 million in 2002 and $5.3 million in 2003. During 2002, the Company will perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002 and has not yet determined what the effect of these tests will be on the earnings and financial position of the Company. 8 ================================================================================ Forward Looking Statements This report contains forward-looking statements within the meaning of federal securities laws that relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "can," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "intend," "potential" or "continue" or the negative of these terms or other comparable terminology. Risks and uncertainties and the occurrence of other events could cause actual results to differ materially from these predictions. Factors that could cause or contribute to such differences include those discussed below under "--Risk Factors," as well as those discussed in our Annual Report on Form 10-K for the year ended December 31, 2000. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this report or to conform these statements to actual results. ================================================================================ Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Maxygen was founded in May 1996 and began operations in March 1997. To date, we have generated revenues from research collaborations with agriculture, pharmaceutical, petroleum, and chemical companies and from government grants. Our current collaborators are Novozymes, DuPont, Pfizer, Syngenta, DSM, Rio Tinto, Lundbeck, Chevron, Hercules, ALK-Abello and IAVI. Our government grants are from the Defense Advanced Research Projects Agency and the National Institute of Standards and Technology-Advanced Technology Program. Revenue under strategic alliances and government grants increased from $14.0 million in 1999 to $24.5 million in 2000 and was $14.6 million in the six months ended June 30, 2001. Revenues may fluctuate from period to period and there can be no assurance that these collaboration agreements will continue for their initial term or beyond. We have incurred significant losses since our inception. As of June 30, 2001, our accumulated deficit was $106.4 million and total stockholders' equity was $267.8 million. We have invested heavily in establishing our proprietary technologies. These investments have contributed to the increases in operating expenses from $26.7 million in 1999 to $99.4 million in 2000 and $44.7 million in the six months ended June 30, 2001. Our total headcount increased from 143 employees at the end of 1999 to 252 employees at the end of 2000. As of June 30, 2001 Maxygen had 287 employees, of whom 85% were engaged in research and development. We expect to incur additional operating losses over at least the next several years as we continue to expand our research and development efforts and infrastructure. Source of Revenue and Revenue Recognition Policy We recognize revenues from research collaboration agreements as earned upon achievement of the performance requirements of the agreements. Revenue related to grant agreements is recognized as related research and development expenses are incurred. Our existing corporate collaboration agreements generally provide for research funding for a specified number of full time researchers working in defined research programs. Revenue related to these payments is earned as the related research work is performed. In addition, these collaborators generally make technology advancement payments that are intended to fund development of our core technology, as opposed to a defined research program. These payments are recognized ratably over the applicable funding period. Payments received that are related to future performance are deferred and recognized as revenue as the performance requirements are achieved. As of June 30, 2001, we have deferred revenues of approximately $11.4 million. Our sources 9 of potential revenue for the next several years are likely to be license, research, technology advancement and milestone payments under existing and possible future collaborative arrangements, government research grants, and royalties from our collaborators based on revenues received from any products commercialized under those agreements. Deferred Compensation Deferred compensation for options granted to employees has been determined as the difference between the deemed fair market value for financial reporting purposes of our common stock on the date the applicable options were granted and the exercise price. Deferred compensation for options granted to consultants has been determined in accordance with Statement of Financial Accounting Standards No. 123 as the fair value of the equity instruments issued. Compensation for related options granted to consultants is periodically remeasured as the underlying options vest. In connection with the grant of stock options to employees before our initial public offering, we recorded deferred stock compensation of approximately $2.4 million in 1998 and $19.5 million in 1999. These amounts were initially recorded as a component of stockholders' equity and are being amortized as charges to operations over the vesting period of the options using a graded vesting method. We recognized stock compensation expense of approximately $4.9 million in 1999, $7.8 million in 2000 and $2.6 million in the six months ended June 30, 2001 related to the deferred compensation amortization on these option grants. In connection with the grant of stock options to consultants, we recorded stock compensation expense of $0.8 million in 1999, $3.0 million in 2000 and $122,000 in the six months ended June 30, 2001. Due to the acceleration of an executive stock option award, an additional $1.6 million stock compensation expense was recorded in 2000. In connection with the Maxygen ApS acquisition in August 2000, stock options were granted in exchange for outstanding warrants to purchase Maxygen ApS securities. In connection with this exchange we recorded aggregate deferred compensation totaling $1.5 million. This amount is being amortized over the remaining vesting period of the options, of which $298,000 was expensed in 2000 and $357,000 in the six months ended June 30, 2001. For the shares exchanged that had a right of repurchase, deferred compensation of $13.1 million was recorded. This amount is being amortized to expense over a three year graded vesting period. A total of $3.3 million was recognized as expense in 2000 and $4.0 million in the six months ended June 30, 2001. Results of Operations Revenues Our total revenues increased from $6.2 million and $11.6 million in the three and six months ended June 30, 2000, to $7.7 million and $14.6 million in the comparable periods of 2001. The increase in collaborative research and development revenue was due to additional strategic alliances and the expansion of existing alliances. The decline in grant revenue reflects the expiration of two government grants that began in late 1997 and early 1998. We expect our total revenues to increase in 2001 as new projects are initiated under existing collaboration agreements and as new collaboration arrangements are consummated. Research and Development Expenses Our research and development expenses consist primarily of salaries and other personnel-related expenses, facility costs, supplies and depreciation of facilities and laboratory equipment. Research and development expenses increased from $9.7 million and $19.5 million in the three and six months ended June 30, 2000, to $15.9 million and $31.5 million in the comparable periods of fiscal 2001. The increase is primarily due to our accelerated efforts in all aspects of research and development, including increased expenditures resulting from our acquisition of Maxygen ApS in August 2000, as well as investments in our technology platforms and in the development of product candidates. Also included in research and development expenses is stock compensation expense of $1.9 million and $5.5 million in the three and six months ended June 30, 2000 and $2.9 million and $5.8 million in the comparable periods of fiscal 2001. Research and development expenses represented 158% and 169% of total revenues in the three and six months ended June 30, 2000 and 207% and 216% of total revenues in the comparable periods of 2001. 10 The increase was due primarily to increased staff necessary to manage and support our growth plus increased research and development costs resulting from our acquisition of Maxygen ApS, offset in part by the growth in our total revenues. We expect research and development cost to increase during the remainder of 2001 as new projects are initiated under existing collaboration agreements and as new collaboration arrangements are consummated. We expect to continue to devote substantial resources to research and development, and we expect that research and development expenses will continue to increase in absolute dollars for at least the next several years. The acquisition of Maxygen ApS has significantly increased our research and development expenses in absolute dollars. General and Administrative Expenses Our general and administrative expenses consist primarily of personnel costs for finance, human resources, business development, legal and general management, as well as professional expenses, such as legal and accounting. General and administrative expenses increased from $4.1 million and $7.5 million in the three and six months ended June 30, 2000, to $4.6 million and $8.8 million in the comparable periods of 2001. Expenses increased primarily due to increased staffing necessary to manage and support our growth. Also included in general and administrative expenses is stock compensation expense of $1.3 million and $2.7 million in the three and six months ended June 30, 2000, and $637,000 and $1.3 million in the comparable periods of 2001. General and administrative expenses represented 67% and 65% of total revenues for the three and six months ended June 30, 2000, and 60% and 60% of total revenues for the comparable periods of 2001. The decrease was due primarily to the growth in our total revenue between periods. We expect that our general and administrative expenses will increase in absolute dollar amounts for at least the next several years as we expand our legal and accounting staff, add infrastructure and investor relations programs and increased professional fees. We also expect that general and administrative expenses will increase in absolute dollar amounts due to the increased costs associated with integrating, operating and coordinating our recently acquired operations in Denmark. We expect that general and administrative expenses as a percentage of total revenue will continue to decrease as our revenues increase and research and development activities expand more quickly than our general and administrative expenses. In-Process Research and Development On May 8, 2000, we acquired certain in-process technology through the acquisition of a privately held California corporation. In connection with the acquisition we issued 39,600 shares of our common stock. Pursuant to the terms of the acquisition agreement, 18,500 shares of our common stock are being held in escrow until such time contingencies regarding the patents related to the acquired technology are resolved. Accordingly, we have recorded a charge for acquired in-process research and development of $912,000 representing the fair value of the 21,100 shares delivered to the sellers at closing, plus certain transaction expenses. Shares in escrow will be valued and accounted for when, and if, the contingencies are resolved and the shares are delivered to the sellers. As opportunities present themselves, we intend to continue to acquire new technologies and companies. Such acquisitions could lead to additional direct and indirect expenses that could negatively affect our results of operations. Goodwill and Other Intangible Assets In connection with the Maxygen ApS acquisition, we allocated $26.2 million to goodwill and other intangible assets and will amortize this goodwill and other intangible assets over three years, the term of expected benefit. We believe this term is reasonable given that Maxygen ApS was a development stage entity and its technology is at an early stage of development and is yet unproven. Amortization expense of $3.4 million in 2000 and $4.4 million in the six months ended June 30, 2001 was recorded on goodwill and other intangible assets. Goodwill and other intangible assets are generally evaluated on an individual acquisition or market basis whenever events or changes in circumstances indicate that such assets are impaired or the estimated useful lives are no longer appropriate. If indicators of impairment exist, we will review our long-lived 11 assets (including goodwill) for impairment based on estimated future discounted cash flows attributable to the assets. In the event such cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values. No impairment charges have been recorded in 2000 or in the six months ended June 30, 2001. In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over the useful lives. The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the nonamortization provisions of the Statement is expected to result in a decrease in net loss of $8.7 million in 2002 and $5.3 million in 2003. During 2002, the Company will perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002 and has not yet determined what the effect of these tests will be on the earnings and financial position of the Company. Net Interest Income Net interest income represents income earned on our cash, cash equivalents and marketable securities net of interest expense. Net interest income increased from $4.3 million and $6.4 million in the three and six months ended June 30, 2000 to $3.5 million and $7.4 million in the comparable periods of 2001. This increase was due to higher average balances of cash, cash equivalents and marketable securities. Liquidity and Capital Resources Since inception, we have financed our operations primarily through private placements and public offerings of equity securities, receiving aggregate consideration from such sales totaling $302.5 million and research and development funding from collaborators and government grants totaling approximately $64.4 million. As of June 30, 2001, we had $251.6 million in cash, cash equivalents and investments. Our operating activities used cash of $2.3 million in the six months ended June 30, 2000 and $4.0 million in the six months ended June 30, 2001. Uses of cash in operating activities were primarily to fund net operating losses. Net cash used in investing activities was $58.1 million in the six months ended June 30, 2000 and $37.1 million in the six months ended June 30, 2001. The cash used during the six months ended June 30, 2000 and 2001 primarily represented purchases of available-for-sale securities. This was partially offset by the maturities of available-for-sale securities and the conversion of some cash and cash equivalents into longer term investments. Additions of property and equipment were $1.1 million in the six months ended June 30, 2000 and $3.3 million in the six months ended June 30, 2001 which includes a $261,000 adjustment from foreign currency translation at June 30, 2001. The increase is primarily due to the expansion of our offices and laboratories in Redwood City as well as new equipment purchased at Maxygen ApS. We expect to continue to make significant investments in the purchase of property and equipment to support our expanding operations. We may use a portion of our cash to acquire or invest in complementary businesses, products or technologies, or to obtain the right to use such complementary technologies. Financing activities provided cash of $137.9 million in the six months ended June 30, 2000 and $136,000 in the six months ended June 30, 2001. The 2000 amount primarily consists of the net proceeds received from the sale of common stock in a follow-on public offering in March 2000. The cash provided in the six months ended June 30, 2001 was primarily from the proceeds of the sale of common stock in connection with Maxygen's Employee Stock Purchase Plan, the Company's matching contribution for the 401(k) Plan, and the exercise of stock options by employees. This was partially offset by an equity adjustment from foreign currency translation of $972,000 and payments on equipment financing obligations of $249,000. Assuming our research efforts for existing collaborations are expended for the full research term, as of June 30, 2001 we have total committed funding of $118.7 million, of which approximately $91.5 million is from our collaborators and $27.2 million is from government funding. Of these committed funds, we have $54.3 million remaining to be received over the next four years. In addition, potential milestone payments from our existing collaborations could exceed $240 million based on the accomplishment of specific performance criteria, and we may earn royalties on product sales. In general, the obligation of our corporate collaborators to provide research funding cannot be terminated by either party before the end of the research term unless there has been a material breach of contract or either party has become bankrupt or insolvent. In the case of such an event, the agreement specifies the rights, if any, that each party will retain. We believe that our current cash, cash equivalents, short-term investments and long-term investments together with funding received from collaborators and government grants will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. However, it is possible that we will seek additional financing within this timeframe. We may raise 12 additional funds through public or private financing, collaborative relationships or other arrangements. Additional funding, if sought, may not be available on terms favorable to us. Further, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. Our failure to raise capital when needed may harm our business and operating results. RISK FACTORS THAT MAY AFFECT RESULTS OF OPERATIONS AND FINANCIAL CONDITION You should carefully consider the risks described below, together with all of the other information included in this report, in considering our business and prospects. The risks and uncertainties described below are not the only ones facing Maxygen. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business could be harmed. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment. We Have a History of Net Losses. We Expect to Continue to Incur Net Losses and We May Not Achieve or Maintain Profitability. We have incurred net losses since our inception, including a net loss of approximately $59.6 million for the year ended December 31, 2000 and $22.6 million for the six months ended June 30, 2001. As of June 30, 2001, we had an accumulated deficit of approximately $106.4 million. We expect to have increasing net losses and negative cash flow for at least the next several years. The size of these net losses will depend, in part, on the rate of growth, if any, in our contract revenues and on the level of our expenses. To date, we have derived all our revenues from collaborations and grants and expect to do so for at least the next several years. Revenues from collaborations and grants are uncertain because our existing agreements have fixed terms and because our ability to secure future agreements will depend upon our ability to address the needs of our potential future collaborators. We expect to spend significant amounts to fund research and development and enhance our core technologies. As a result of our acquisition of Maxygen ApS, we expect costs to increase further due to expanded operations, integration costs associated with the acquisition and costs associated with operating in multiple international locations. As a result, we expect that our operating expenses will increase significantly in the near term and, consequently, we will need to generate significant additional revenues to achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Commercialization of Our Technologies Depends On Collaborations With Other Companies. If We Are Unable to Find Collaborators in the Future, We May Not Be Able to Develop Our Technologies or Products. Since we do not currently possess the resources necessary to develop and commercialize potential products that may result from our technologies, or the resources to complete any approval processes that may be required for these products, we must enter into collaborative arrangements to develop and commercialize products. We have entered into collaborative agreements with other companies to fund the development of certain new products for specific purposes. These contracts expire after a fixed period of time. If they are not renewed or if we do not enter into new collaborative agreements, our revenues will be reduced and our products may not be commercialized. We have limited or no control over the resources that any collaborator may devote to our products. Any of our present or future collaborators may not perform their obligations as expected. These collaborators may breach or terminate their agreement with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. Further, our collaborators may elect not to develop products arising out of our collaborative arrangements or devote sufficient resources to the development, manufacture, marketing or sale of these products. If any of these events occur, we may not be able to develop our technologies or commercialize our products. We Are an Early Stage Company Deploying Unproven Technologies. If We Do Not Develop Commercially Successful Products, We May Be Forced to Cease Operations. You must evaluate us in light of the uncertainties and complexities affecting an early stage biotechnology company. Our proprietary technologies are new and in the early stage of development. We may not develop products that prove to be safe and efficacious, meet applicable regulatory standards, are capable of being manufactured at reasonable costs, or can be marketed successfully. 13 We may not be successful in the commercial development of products. Successful products will require significant development and investment, including testing, to demonstrate their cost-effectiveness before their commercialization. To date, companies in the biotechnology industry have developed and commercialized only a limited number of products. We have not proven our ability to develop and commercialize products. We must conduct a substantial amount of additional research and development before any regulatory authority will approve any of our products. Our research and development may not indicate that our products are safe and effective, in which case regulatory authorities may not approve them. Problems frequently encountered in connection with the development and utilization of new and unproven technologies and the competitive environment in which we operate might limit our ability to develop commercially successful products. We Intend to Conduct Proprietary Research Programs, and Any Conflicts With Our Collaborators or Any Inability to Commercialize Products Resulting from This Research Could Harm Our Business. An important part of our strategy involves conducting proprietary research programs. We may pursue opportunities in fields that could conflict with those of our collaborators. Moreover, disagreements with our collaborators could develop over rights to our intellectual property. Any conflict with our collaborators could reduce our ability to obtain future collaboration agreements and negatively impact our relationship with existing collaborators, which could reduce our revenues. Certain of our collaborators could also become competitors in the future. Our collaborators could develop competing products, preclude us from entering into collaborations with their competitors, fail to obtain timely regulatory approvals, terminate their agreements with us prematurely or fail to devote sufficient resources to the development and commercialization of products. Any of these developments could harm our product development efforts. We will either commercialize products resulting from our proprietary programs directly or through licensing to other companies. We have no experience in manufacturing and marketing, and we currently do not have the resources or capability to manufacture products on a commercial scale. In order for us to commercialize these products directly, we would need to develop, or obtain through outsourcing arrangements, the capability to manufacture, market and sell products. We do not have these capabilities, and we may not be able to develop or otherwise obtain the requisite manufacturing, marketing and sales capabilities. If we are unable to successfully commercialize products resulting from our proprietary research efforts, we will continue to incur losses. We May Encounter Difficulties in Managing Our Growth. These Difficulties Could Increase Our Losses. We have experienced rapid and substantial growth that has placed and, if this growth continues as expected, will continue to place a strain on our human and capital resources. If we are unable to manage this growth effectively, our losses could increase. The number of our employees increased from 74 at December 31, 1998 to 143 at December 31, 1999 to 252 at December 31, 2000 to 287 at June 30, 2001. Our revenues increased from $2.7 million in 1998 to $14.0 million in 1999 to $24.5 million in 2000 and were $14.6 million for the six months ended June 30, 2001. Our ability to manage our operations and growth effectively requires us to continue to expend funds to enhance our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees. If we are unable to implement improvements to our management information and control systems in an efficient or timely manner, or if we encounter deficiencies in existing systems and controls, then management may have access to inadequate information to manage our day-to-day operations. Failure to attract and retain sufficient numbers of talented employees will further strain our human resources and could impede our growth and ability to satisfy our obligations under collaboration agreements. This would reduce our revenue, increase our losses and harm our reputation in the marketplace. 14 The Operation of International Locations May Increase Operating Expenses and Divert Management Attention. We are expanding internationally. We recently acquired Maxygen ApS, a Danish biotechnology company, and are now operating with international business locations. Expansion into an international operational entity will require additional management attention and resources. We have limited experience in localizing our operations and in conforming our operations to local cultures, standards and policies. We may have to compete with local companies who understand the local situation better than we do. We may not be successful in expanding into international locations or in generating revenues from foreign operations. Even if we are successful, the costs of operating internationally are expected to exceed our international revenues for at least the next several years. As we continue to expand internationally, we are subject to risks of doing business internationally, including the following: . regulatory requirements that may limit or prevent the offering of our products in local jurisdictions; . government limitations on research and/or research involving genetically engineered products or processes; . difficulties in staffing and managing foreign operations; . longer payment cycles, different accounting practices and problems in collecting accounts receivable; . cultural non-acceptance of genetic manipulation and genetic engineering; and . potentially adverse tax consequences. To the extent we expand our international operations and have additional portions of our international revenues denominated in foreign currencies, we also could become subject to increased difficulties in collecting accounts receivable and risks relating to foreign currency exchange rate fluctuations. Acquisitions Could Result in Dilution, Operating Difficulties and Other Harmful Consequences. If appropriate opportunities present themselves, we intend to acquire businesses and technologies that complement our capabilities. The process of integrating any acquisition may create unforeseen operating difficulties and expenditures and is itself risky. The areas where we may face difficulties include: . diversion of management time (both ours and that of the acquired company) from focus on operating the businesses to issues of integration and future products during the period of negotiation through closing and further diversion of such time after closing; . decline in employee morale and retention issues resulting from changes in compensation, reporting relationships, future prospects, or the direction of the business; . the need to integrate each company's accounting, management information, human resource and other administrative systems to permit effective management and the lack of control if such integration is delayed or not implemented; and . the need to implement controls, procedures and policies appropriate for a larger public company in companies that before acquisition had been smaller, private companies. We do not have extensive experience in managing this integration process. Moreover, the anticipated benefits of any or all of these acquisitions may not be realized. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities or amortization expenses related to goodwill and other intangible assets, any of which could harm our business. Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all. Even if available, this financing may be dilutive. Since Our Technologies Can Be Applied to Many Different Industries, If We Focus Our Efforts on Industries That Fail to Produce Viable Product Candidates, We May Fail to Capitalize on More Profitable Areas. We have limited financial and managerial resources. Since our technologies may be applicable to numerous, diverse industries, we must prioritize our application of resources to discrete efforts. This requires us to focus on product candidates in selected industries and forego efforts with regard to other 15 products and industries. Our decisions may not produce viable commercial products and may divert our resources from more profitable market opportunities. Public Perception of Ethical and Social Issues May Limit the Use of Our Technologies, Which Could Reduce Our Revenues. Our success will depend in part upon our ability to develop products discovered through our proprietary and non-proprietary technologies. Governmental authorities could, for social or other purposes, limit the use of genetic processes or prohibit the practice of our directed molecular evolution technologies or other technologies. Ethical and other concerns about our directed molecular evolution technologies or other technologies, particularly the use of genes from nature for commercial purposes, and products resulting therefrom, could adversely affect their market acceptance. If the Public Rejects Genetically Engineered Products, We Will Have Less Demand for Our Products. The commercial success of our potential products will depend in part on public acceptance of the use of genetically engineered products including drugs, plants and plant products. Claims that genetically engineered products are unsafe for consumption or pose a danger to the environment may influence public attitudes. Our genetically engineered products may not gain public acceptance. Negative public reaction to genetically modified organisms and products could result in greater government regulation of genetic research and resultant products, including stricter labeling laws or regulations, and could cause a decrease in the demand for our products. The subject of genetically modified organisms has received negative publicity in Europe and the United States, which has aroused public debate. The adverse publicity could lead to greater regulation and trade restrictions on genetic research and the resultant agricultural and other products could be subject to greater domestic or international regulation. Such regulation and restrictions could cause a decrease in the demand for our products. Many Potential Competitors Who Have Greater Resources and Experience Than We Do May Develop Products and Technologies That Make Ours Obsolete. The biotechnology industry is characterized by rapid technological change, and the area of gene research is a rapidly evolving field. Our future success will depend on our ability to maintain a competitive position with respect to technological advances. Rapid technological development by others may result in our products and technologies becoming obsolete. We face, and will continue to face, intense competition from organizations such as large and small biotechnology companies, as well as academic and research institutions and government agencies that are pursuing competing technologies for modifying DNA and proteins. These organizations may develop technologies that are alternatives to our technologies. Further, our competitors in the directed molecular evolution field may be more effective at implementing their technologies to develop commercial products. Some of these competitors have entered into collaborations with leading companies within our target markets to produce commercial products. Any products that we develop through our technologies will compete in multiple, highly competitive markets. Most of the organizations competing with us in the markets for such products have greater capital resources, research and development and marketing staffs and facilities and capabilities, and greater experience in modifying DNA and proteins, obtaining regulatory approvals, manufacturing products and marketing. Accordingly, our competitors may be able to develop technologies and products more easily, which would render our technologies and products and those of our collaborators obsolete and noncompetitive. Any Inability to Adequately Protect Our Proprietary Technologies Could Harm Our Competitive Position. Our success will depend in part on our ability to obtain patents and maintain adequate protection of our other intellectual property for our technologies and products in the U.S. and other countries. If we do not 16 adequately protect our intellectual property, competitors may be able to practice our technologies and erode our competitive advantage. The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the U.S., and many companies have encountered significant problems in protecting their proprietary rights in these foreign countries. These problems can be caused by, for example, a lack of rules and processes for defending intellectual property rights. The patent positions of biopharmaceutical and biotechnology companies, including our patent positions, are generally uncertain and involve complex legal and factual questions. We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. We will apply for patents covering our technologies and products as we deem appropriate. However, we may not obtain patents on all inventions that we seek to protect with patents, and any patents we obtain may be challenged and may be narrowed in scope or extinguished as a result of such challenges. Our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies. Others may independently develop similar or alternative technologies or design around our patented technologies. Furthermore, our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from developing competing products. In addition, others may challenge or invalidate our patents, or our patents may fail to provide us with any competitive advantages. We rely upon trade secret protection for our confidential and proprietary information. We have taken security measures to protect our proprietary information. These measures may not provide adequate protection for our trade secrets or other proprietary information. We seek to protect our proprietary information by entering into confidentiality agreements with employees, collaborators and consultants. Nevertheless, employees, collaborators or consultants may still disclose or misuse our proprietary information, and we may not be able to meaningfully protect our trade secrets. In addition, others may independently develop substantially equivalent proprietary information or techniques or otherwise gain access to our trade secrets. Litigation or Other Proceedings or Third Party Claims of Intellectual Property Infringement Could Require Us to Spend Time and Money and Could Shut Down Some of Our Operations. Our commercial success depends in part on neither infringing patents nor proprietary rights of third parties, nor breaching any licenses that we have entered into with regard to our technologies and products. Others have filed, and in the future are likely to file, patent applications covering genes or gene fragments that we may wish to utilize with our proprietary technologies, or products that are similar to products developed with the use of our technologies or alternative methods of generating gene diversity. If these patent applications result in issued patents and we wish to use the claimed technology, we would need to obtain a license from the third party. Third parties may assert that we are employing their proprietary technology without authorization. In addition, third parties may obtain patents in the future and claim that use of our technologies infringes these patents. We could incur substantial costs and diversion of the time and attention of management and technical personnel in defending ourselves against any of these claims or enforcing our patents or other intellectual property rights against others. Furthermore, parties making claims against us may be able to obtain injunctive or other equitable relief that could effectively block our ability to further develop, commercialize and sell products, and such claims could result in the award of substantial damages against us. In the event of a successful claim of infringement against us, we may be required to pay damages and obtain one or more licenses from third parties. We may not be able to obtain these licenses at a reasonable cost, if at all. In that event, we could encounter delays in product introductions while we attempt to develop alternative methods or products or be required to cease commercializing effected products. We routinely monitor the public disclosures of other companies operating in our industry regarding their technological development efforts. If we determine that these efforts violate our intellectual property or other rights, we intend to take appropriate action, which could include litigation. Any action we take could result in substantial costs and diversion of management and technical personnel. Furthermore, the outcome of any action we take to protect our rights may not be resolved in our favor. On April 27, 2000, we announced that we had initiated an arbitration proceeding against Enchira in connection with Enchira's claim that it had developed a "new gene shuffling" technology. We alleged that 17 Enchira had breached the confidentiality provisions and certain other terms of the Development and License Agreement entered into by Enchira and Maxygen in 1997, pursuant to which we disclosed confidential information regarding our MolecularBreeding directed molecular evolution technologies to Enchira. An arbitration hearing was held in November 2000 and on March 8, 2001 we announced that the arbitrator had found that Enchira had breached three separate provisions of the Development and License Agreement. The arbitrator found that the gene shuffling technology that Enchira calls Rachitt, and claims as its own, "was derived from Maxygen's technologies and has no notable or significant distinctions from those technologies" and that "Maxygen is the exclusive owner of the gene shuffling technology contained in Rachitt". The arbitrator also found that Enchira had misused our confidential information. There will be further arbitration proceedings in 2001 to determine the remedies we will receive for Enchira's breaches of the Agreement. If We Lose Key Personnel or Are Unable to Attract and Retain Additional Personnel We May Be Unable to Pursue Collaborations or Develop Our Own Products. We are highly dependent on the principal members of our management and scientific staff, the loss of whose services might adversely impact the achievement of our objectives. In addition, recruiting and retaining qualified scientific personnel to perform future research and development work will be critical to our success. We do not currently have sufficient executive management personnel to execute fully our business plan. There is currently a shortage of skilled executives, which is likely to continue. As a result, competition for skilled personnel is intense, and the turnover rate can be high. Although we believe we will be successful in attracting and retaining qualified personnel, competition for experienced scientists from numerous companies and academic and other research institutions may limit our ability to do so on acceptable terms. Failure to attract and retain personnel could prevent us from pursuing collaborations or developing our products or core technologies. Our planned activities will require additional expertise in specific industries and areas applicable to the products developed through our technologies. These activities will require the addition of new personnel, including management, and the development of additional expertise by existing management personnel. The inability to acquire these services or to develop this expertise could impair the growth, if any, of our business. We Will Need Additional Capital in the Future. If Additional Capital is Not Available, We Will Have to Curtail or Cease Operations. Our future capital requirements will be substantial and will depend on many factors including payments received under collaborative agreements and government grants, the progress and scope of our collaborative and independent research and development projects, the effect of any acquisitions, and the filing, prosecution and enforcement of patent claims. Changes may also occur that would consume available capital resources significantly sooner than we expect. We may be unable to raise sufficient additional capital. If we fail to raise sufficient funds, we will have to curtail or cease operations. We anticipate that existing cash and cash equivalents and income earned thereon, together with anticipated cash flows from operations, will enable us to maintain our currently planned operations for at least the next 12 months. If our capital resources are insufficient to meet future capital requirements, we will have to raise additional funds to continue the development of our technologies and complete the commercialization of products, if any, resulting from our technologies. Some of Our Programs Depend on Government Grants, Which May Be Withdrawn. The Government Has License Rights to Technology Developed With Its Funds. We have received and expect to continue to receive funds under various U.S. government research and technology development programs. The government may reduce funding in the future for a number of reasons. For example, some programs are subject to a yearly appropriations process in Congress. Additionally, we may not receive funds under existing or future grants because of budgeting constraints of the agency administering the program. There can be no assurance that we will receive the entire funding under our existing or future grants. 18 Our grants provide the U.S. government a non-exclusive, non-transferable, paid-up license to practice for or on behalf of the U.S. inventions made with federal funds. If the government exercises these rights, the U.S. government could use these inventions and our potential market could be reduced. Our Potential Therapeutic Products Are Subject to a Lengthy and Uncertain Regulatory Process. If Our Potential Products Are Not Approved, We Will Not Be Able to Commercialize Those Products. The Food and Drug Administration must approve any vaccine or therapeutic product before it can be marketed in the U.S. Before we can file a new drug application or biologic license application with the FDA, the product candidate must undergo extensive testing, including animal and human clinical trials, which can take many years and require substantial expenditures. Data obtained from such testing are susceptible to varying interpretations that could delay, limit or prevent regulatory approval. In addition, changes in regulatory policy for product approval during the period of product development and regulatory agency review of each submitted new application or product license application may cause delays or rejections. The regulatory process is expensive and time consuming. The regulatory agencies of foreign governments must also approve our therapeutic products before the products can be sold in those other countries. Because our products involve the application of new technologies and may be based upon new therapeutic approaches they may be subject to substantial review by government regulatory authorities and government regulatory authorities may grant regulatory approvals more slowly for our products than for products using more conventional technologies. We have not submitted an application to the FDA or any other regulatory authority for any product candidate, and neither the FDA nor any other regulatory authority has approved any therapeutic product candidate developed with our MolecularBreeding directed molecular evolution technologies for commercialization in the U.S. or elsewhere. We may not be able to, or our collaborators may not be able to, conduct clinical testing or obtain the necessary approvals from the FDA or other regulatory authorities for our products. Even after investing significant time and expenditures we may not obtain regulatory approval for our products. Even if we receive regulatory approval, this approval may entail limitations on the indicated uses for which we can market a product. Further, once regulatory approval is obtained, a marketed product and its manufacturer are subject to continual review, and discovery of previously unknown problems with a product or manufacturer may result in restrictions on the product, manufacturer or manufacturing facility, including withdrawal of the product from the market. In certain countries, regulatory agencies also set or approve prices. Laws May Limit Our Provision of Genetically Engineered Agricultural Products in the Future. These Laws Could Reduce Our Ability to Sell These Products. We may develop genetically engineered agricultural products. The field-testing, production and marketing of genetically engineered plants and plant products are subject to federal, state, local and foreign governmental regulation. Regulatory agencies administering existing or future regulations or legislation may not allow us to produce and market our genetically engineered products in a timely manner or under technically or commercially feasible conditions. In addition, regulatory action or private litigation could result in expenses, delays or other impediments to our product development programs or the commercialization of resulting products. The FDA currently applies the same regulatory standards to foods developed through genetic engineering as apply to foods developed through traditional plant breeding. However, genetically engineered food products will be subject to pre-market review if these products raise safety questions or are deemed to be food additives. Our products may be subject to lengthy FDA reviews and unfavorable FDA determinations if they raise questions, are deemed to be food additives, or if the FDA changes its policy. The FDA has also announced in a policy statement that it will not require that genetically engineered agricultural products be labeled as such, provided that these products are as safe and have the same nutritional characteristics as conventionally developed products. The FDA may reconsider or change its labeling policies, or local or state authorities may enact labeling requirements. Any such labeling requirements could reduce the demand for our products. 19 The U.S. Department of Agriculture prohibits genetically engineered plants from being grown and transported except pursuant to an exemption, or under strict controls. If our future products are not exempted by the USDA, it may be impossible to sell such products. Adverse Events in the Field of Gene Therapy May Negatively Impact Regulatory Approval or Public Perception of Any Gene Therapy Products We or Our Collaborators May Develop. Currently, we are not engaged in developing gene therapy products; however, we may engage in these activities in the future either for our own account or with collaborators. If we develop, or our collaborators develop, gene therapy products, these products may encounter substantial delays in development and approval due to the government regulation and approval process. Adverse events reported in gene therapy clinical trials may lead to more government scrutiny of proposed clinical trials of gene therapy products, stricter labeling requirements for these products and delays in the approval of gene therapy products for commercial sale. The commercial success of any potential gene therapy products made by us or our collaborators will depend in part on public acceptance of the use of gene therapies for the prevention or treatment of human diseases. Public attitudes may be influenced by claims that gene therapies are unsafe, and gene therapy products may not gain the acceptance of the public or the medical community. Negative public reaction to gene therapy could result in a decrease in demand for any gene therapy products we or our collaborators may develop. Health Care Reform and Restrictions on Reimbursements May Limit Our Returns on Pharmaceutical Products. Our future products are expected to include pharmaceutical products. Our ability and that of our collaborators to commercialize pharmaceutical products developed with our technologies may depend in part on the extent to which reimbursement for the cost of these products will be available from government health administration authorities, private health insurers and other organizations. Third-party payors are increasingly challenging the price of medical products and services. Significant uncertainty exists as to the reimbursement status of newly approved health care products, and there can be no assurance that adequate third party coverage will be available for any product to enable us to maintain price levels sufficient to realize an appropriate return on our investment in research and product development. Our Collaborations With Outside Scientists May Be Subject to Change, Which Could Limit Our Access to Their Expertise. We work with scientific advisors, consultants and collaborators at academic and other institutions. These scientists are not our employees and may have other commitments that could limit their availability to us. Although our scientific advisors generally agree not to do competing work, if a conflict of interest between their work for us and their work for another entity arises, we may lose their services. Although our scientific advisors and collaborators sign agreements not to disclose our confidential information, it is possible that certain of our valuable proprietary knowledge may become publicly known through them. We May Be Sued for Product Liability. We may be held liable if any product we develop, or any product that is made with the use or incorporation of, any of our technologies, causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing or sale. These risks are inherent in the development of chemical, agricultural and pharmaceutical products. Although we intend in the future to obtain product liability insurance, we do not have such insurance currently and this insurance may be prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of products developed by us or our collaborators. If we are sued for any injury caused by our products, our liability could exceed our total assets. 20 We Use Hazardous Chemicals and Radioactive and Biological Materials in Our Business. Any Claims Relating to Improper Handling, Storage or Disposal of These Materials Could Be Time Consuming and Costly. Our research and development processes involve the controlled use of hazardous materials, including chemicals, radioactive and biological materials. Some of these materials may be novel, including viruses with novel properties and animal models for the study of viruses. Our operations also produce hazardous waste products. Some of our work also involves the development of novel viruses and viral animal models. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We believe that our current operations comply in all material respects with these laws and regulations. We could be subject to civil damages in the event of an improper or unauthorized release of, or exposure of individuals to, hazardous materials. In addition, claimants may sue us for injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our total assets. Compliance with environmental laws and regulations may be expensive, and current or future environmental regulations may impair our research, development, or production efforts. We believe that our current operations comply in all material respects with applicable Environmental Protection Agency regulations. In addition, certain of our collaborators are working with these types of hazardous materials in connection with our collaborations. To our knowledge, the work is performed in accordance with biosafety regulations. In the event of a lawsuit or investigation, we could be held responsible for any injury caused to persons or property by exposure to, or release of, these viruses and hazardous materials. Further, under certain circumstances, we have agreed to indemnify our collaborators against damages and other liabilities arising out of development activities or products produced in connection with these collaborations. Our Stock Price Has Been, and May Continue to Be, Extremely Volatile. The trading prices of life science company stocks in general, and ours in particular, have experienced extreme price fluctuations in recent months. The valuations of many life science companies without consistent product revenues and earnings, including ours, are high based on conventional valuation standards such as price to earnings and price to sales ratios. These trading prices and valuations may not be sustained. Any negative change in the public's perception of the prospects of biotechnology or life science companies could depress our stock price regardless of our results of operations. Other broad market and industry factors may decrease the trading price of our common stock, regardless of our performance. Market fluctuations, as well as general political and economic conditions such as recession or interest rate or currency rate fluctuations, also may decrease the trading price of our common stock. In addition, our stock price could be subject to wide fluctuations in response to factors including the following: . announcements of new technological innovations or new products by us or our competitors; . changes in financial estimates by securities analysts; . conditions or trends in the biotechnology and life science industries; . changes in the market valuations of other biotechnology or life science companies; . developments in domestic and international governmental policy or regulations; . announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; . developments in or challenges relating to patent or other proprietary rights; . period-to-period fluctuations in our operating results; . future royalties from product sales, if any, by our strategic partners; and . sales of our common stock or other securities in the open market. In the past, stockholders have often instituted securities class action litigation after periods of volatility in the market price of a company's securities. If a stockholder files a securities class action suit against us, we would incur substantial legal fees and our management's attention and resources would be diverted from operating our business to respond to the litigation. 21 We Expect that Our Quarterly Results of Operations Will Fluctuate, and This Fluctuation Could Cause Our Stock Price to Decline. Our quarterly operating results have fluctuated in the past and are likely to do so in the future. These fluctuations could cause our stock price to fluctuate significantly or decline. Some of the factors that could cause our operating results to fluctuate include: . expiration of research contracts with collaborators or government research grants, which may not be renewed or replaced; . the success rate of our discovery efforts leading to milestones and royalties; . the timing and willingness of collaborators to commercialize our products, which would result in royalties; and . general and industry specific economic conditions, which may affect our collaborators' research and development expenditures. A large portion of our expenses are relatively fixed, including expenses for facilities, equipment and personnel. Accordingly, if revenues decline or do not grow as anticipated due to expiration of research contracts or government research grants, failure to obtain new contracts or other factors, we may not be able to correspondingly reduce our operating expenses. In addition, we plan to significantly increase operating expenses in the second half of 2001. Failure to achieve anticipated levels of revenues could therefore significantly harm our operating results for a particular fiscal period. Due to the possibility of fluctuations in our revenues and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Our operating results in some quarters may not meet the expectations of stock market analysts and investors. In that case, our stock price would likely decline. Some of Our Existing Stockholders Can Exert Control Over Us, and May Not Make Decisions that Are in the Best Interests of All Stockholders. Our executive officers, directors and principal stockholders together control approximately 34% of our outstanding common stock, including GlaxoSmithKline plc, which owns approximately 19% of our outstanding common stock. As a result, these stockholders, if they act together, and GlaxoSmithKline plc by itself, are able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of Maxygen and might affect the market price of our common stock, even when a change may be in the best interests of all stockholders. In addition, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders and accordingly, they could cause us to enter into transactions or agreements that we would not otherwise consider. Item 3 Quantitative and Qualitative Disclosures About Market Risk We are exposed to financial market risks, including changes in interest rates and foreign currency exchange. To mitigate some of these risks, we utilize currency forward contracts. We do not use derivative financial instruments for speculative or trading purposes. Interest Rate Risk The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents, short-term and long-term investments in a variety of securities, including corporate obligations and money market funds. As of June 30, 2001, approximately 71% of our total portfolio will mature in one year or less, with the remainder maturing in less than two years. 22 The following table represents the fair value balance of our cash, cash equivalents, short-term and long-term investments that are subject to interest rate risk by year of expected maturity and average interest rates as of June 30, 2001 (dollars in thousands): 2001 2002 ------------ ------------ Cash and cash equivalents ......... 70,390 Average interest rates ............ 4.20% Short-term investments ............ 107,023 Average interest rates ............ 5.91% Long-term investments ............. 74,187 Average interest rates ............ 5.16% We did not hold derivative instruments intended to mitigate interest rate risk as of June 30, 2001, and we have never held such instruments in the past. In addition, we had outstanding debt related to equipment financing of $2 million as of June 30, 2001, with a range of interest rates of between 11.73% and 12.78%. Foreign Currency Risk A substantial majority of our revenue, expense and capital purchasing activities are transacted in U.S. dollars. However, beginning in 2000 we began to enter into transactions in Danish kroner. To protect against reductions in value and the volatility of future cash flows caused by changes in foreign exchange rates, we have established balance sheet hedging programs. Currency forward contracts are utilized in these hedging programs. Our hedging programs reduce, but do not always entirely eliminate, the impact of foreign currency exchange rate movements. Gains and losses on these foreign currency investments would generally be offset by corresponding losses and gains on the related hedging instruments, resulting in negligible net exposure to Maxygen. At June 30, 2001 we had a total of $9.0 million committed in foreign currency cash flow forward contracts. The fair value of these forward contracts at June 30, 2001 is $858,000 which was reflected on the balance sheet as a liability. 23 ================================================================================ Part II - Other Information Item 1 Legal Proceedings Not applicable. Item 2 Changes in Securities and Use of Proceeds Recent Sales of Unregistered Securities Between May 8, 2001 and June 8, 2001 we issued a total of 16,172 shares of our common stock to a total five consultants and one employee in partial payment for consulting services rendered to us. There was no underwriter employed in connection with any of the transactions. The issuance of securities was deemed to be exempt from registration under the Securities Act of 1933, as amended (the "Securities Act") in reliance on Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering. The recipients of the securities represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates issued in the transactions. The recipients either received adequate information about us or had access, through employment or other relationships, to such information. The recipients, either alone or together with their duly appointed purchaser representatives, were knowledgeable, sophisticated and experienced in making investment decisions of this kind and received adequate information about us. Application of Initial Public Offering Proceeds The effective date of our first registration statement, filed on Form S-1 under the Securities Act (No. 333-89413) relating to our initial public offering of common stock, was December 15, 1999. Net proceeds to us were approximately $101.0 million. From the effective date through June 30, 2001, the proceeds were applied toward: . purchases and installation of equipment and build-out of facilities, $8.5 million; . repayment of indebtedness, $421,000; . working capital, $17.2 million; and . temporary investments in certificates of deposits, mutual funds and corporate debt securities, $74.9 million. The use of the proceeds from the offering does not represent a material change in the use of the proceeds described in the registration statement. Item 3 Defaults Upon Senior Securities Not applicable. 24 Item 4 Submission of Matters to a Vote of Security Holders We held our Annual Meeting of Stockholders on June 1, 2001. The only matter voted upon at the meeting was the election of directors wherein each nominee proposed by us was elected. The number of votes cast for and withheld for each nominee is provided below. Shares Voted For Shares Candidate Candidate Withheld Russell J. Howard ..................... 27,008,229 357,385 Isaac Stein ........................... 27,341,356 24,258 Robert J. Glaser ...................... 27,321,874 43,740 M.R.C. Greenwood ...................... 27,323,134 42,480 Gordon Ringold ........................ 27,340,744 24,870 George Poste .......................... 27,343,377 22,237 Item 5 Other Information Not applicable. Item 6 Exhibits and Reports On Form 8-K (a) The following exhibits are filed as part of this report: 10.1 Form of Change of Control Agreement 10.2 Sublease between Cygnus, Inc. and Maxygen, Inc. dated March 30, 2001 10.3 1999 Nonemployee Directors Stock Option Plan, as amended, with applicable option agreement 10.4 Promissory Note dated May 7, 2001, executed by John Curd in favor of Maxygen, Inc. (b) There were no reports on Form 8-K filed during the quarter ended June 30, 2001. 25 ================================================================================ SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MAXYGEN, INC. August 14, 2001 By: /s/ Russell J. Howard ---------------------------------------- Russell J. Howard Chief Executive Officer August 14, 2001 By: /s/ Lawrence Briscoe ---------------------------------------- Lawrence Briscoe Chief Financial Officer